Changes to “Too Big To Fail”?: Treasury Recommends Revisions to Dodd-Frank SIFI Designation Process for Non-Banks (Part II)

Changes to “Too Big To Fail”?: Treasury Recommends Revisions to Dodd-Frank SIFI Designation Process for Non-Banks (Part II)

Legal Sidebari

Changes to “Too Big To Fail”?: Treasury
Recommends Revisions to Dodd-Frank SIFI
Designation Process for Non-Banks (Part II)
December 1, 2017
As discussed in Part I of this two-part Sidebar, on November 17, the Treasury Department issued a report
recommending a number of changes to the Financial Stability Oversight Council’s (FSOC’s) process for
designating non-bank financial companies as “systemically important financial institutions” (SIFIs)
(colloquially known as institutions that are “Too Big to Fail”) under the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank). While Part I provides a general background on the SIFI
designation process, this Sidebar discusses the legal debate over the designation process, the Treasury
Department’s recommended changes for the process, and how those changes may affect the Senate’s
consideration of the Financial CHOICE Act of 2017, which would repeal FSOC’s authority to designate
non-banks as SIFIs altogether.

The Debate over the SIFI Designation Process

The SIFI designation process has been the subject of much legal debate. As discussed in Part I of this
Sidebar, FSOC is currently engaged in litigation over its designation of MetLife as a SIFI, which was
overturned by the U.S. District Court for the District of Columbia. Moreover, some legal commentators
have criticized FSOC for what they regard as its lack of transparency and failure to adequately
communicate with companies being considered for designation. Other critics argue that the standards
FSOC uses to designate companies as SIFIs are excessively vague. Along these lines, the House
Committee on Financial Services issued a report in February concluding that FSOC has failed to follow
its own guidance for SIFI designations and evaluated companies using inconsistent standards.
On the other hand, defenders of FSOC have argued that the “malleable standard[s]” FSOC applies in
deciding whether to designate companies as SIFIs effectively deter companies from seeking out
systemically risky activities. According to these commentators, the adoption of precise mathematical
formulas for distinguishing between safe and risky companies would encourage companies to seek out
activities with risks that are not adequately reflected in such rigid standards. They contend that vesting
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FSOC with “broad discretion” to designate firms as SIFIs is appropriate given the inherent difficulty of
identifying systemic risks and the perils of failing to identify such risks.

Treasury’s Recommended Changes

The Treasury Department’s latest Report outlines four general recommendations for changing the SIFI
designation process for non-bank financial companies. First, the Report recommends that FSOC adopt an
“activities-based” or “industry-wide” approach to assessing potential risks posed by non-banks. Under
this approach, FSOC would prioritize identifying specific financial activities and products that could pose
risks to financial stability, work with the primary financial regulatory agencies to address those specific
risks, and consider individual firms for designation as SIFIs only as a matter of last resort if more limited
actions aimed at mitigating discrete risks are insufficient to safeguard financial stability.

Second, the Treasury Department recommends that FSOC “increas[e] the analytical rigor” of its
designation analyses. Specifically, the Report recommends that FSOC: (1) consider any factors that might
mitigate the exposure of a firm’s creditors and counterparties, (2) focus on “plausible” (and not merely
“possible”) asset liquidation risks, (3) evaluate the likelihood that a firm will experience financial distress
before evaluating how that distress could be transmitted to other firms, (4) consider the costs and benefits
of designations, and (5) collapse its three-stage review process into two steps–notifying companies that
they are under active review during Stage 1 and voting on proposed designations after the completion of
Stage 2.

Third, the Treasury Department recommends enhancing engagement between FSOC and companies under
review and improving the designation process’s transparency. Specifically, the Report recommends that
FSOC: (1) engage earlier with companies under review and “explain . . . the key risks” that FSOC has
identified, (2) “undertake greater engagement” with companies’ primary financial regulators, and
(3) publicly release explanations of its SIFI designation decisions.
Fourth, the Treasury Department recommends that FSOC provide “a clear off-ramp” for non-banks
designated as SIFIs. Dodd-Frank mandates that FSOC re-evaluate its designations annually, allowing the
agency to rescind a designation if it determines by a two-thirds vote that includes the Secretary of the
Treasury that the company no longer meets the standards for designation. The Treasury Department
recommends that FSOC: (1) as an initial matter, highlight the key risks that led to a company’s
designation, (2) “adopt a more robust and transparent process for its annual reevaluations” that “make[s]
clear how companies can engage with FSOC . . . and what information companies should submit during a
reevaluation,” (3) “develop a process to enable a designated company to discuss potential changes it could
make to address the risks it could pose to financial stability,” and (4) “make clear that the standard it
applies in its annual reevaluations is the same as the standard for an initial designation of a nonbank
financial company.”
The Treasury Department’s recommendations may prove significant if and when the Senate considers the
Financial CHOICE Act of 2017, which passed the House of Representatives in June. Among other
changes to Dodd-Frank, the CHOICE Act repeals FSOC’s authority to designate non-banks as SIFIs. It
remains to be seen whether the proposed changes will resolve current concerns over FSOC’s SIFI
authority. It also remains unclear whether FSOC will act on the Treasury Department’s recommendations.
Finally, it is uncertain how the recommendations, if they were to be adopted by FSOC, would affect the
litigation over MetLife’s designation as a SIFI. As discussed in Part I of this Sidebar, that litigation is

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currently pending before the U.S. Court of Appeals for the District of Columbia Circuit, and implicates
many of the concerns raised by critics of the SIFI designation process.

Author Information

Jay B. Sykes

Legislative Attorney

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